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All stemming from the practice known as “options backdating.” Options backdating occurs when a company issues stock options on one date, but reports in its financials an earlier issue date to create a “strike” or exercise price equal to the earlier date’s lower price.
Another consequence is that the company underrepresents the real nature of an executive’s compensation, perpetuating the myth that options are performance-based incentive compensation.
Fortunately, the government appears to appreciate the difference between backdated options that involve the “intentional alteration of documents or faulty internal control and dating issues arising from ministerial or logistical delays.” Unfortunately, the plaintiffs’ bar is not so discerning.
Public announcements that a company or the SEC is investigating possible backdating issues have spawned a rash of civil suits.
Subsequently, the Securities and Exchange Commission (SEC) took an interest, followed by the securities plaintiffs’ bar and many corporations. The practice of options backdating, apparently widespread from 1996 through 2002, is widely believed to have been short-circuited by the enactment of Sarbanes-Oxley in 2002.
Although backdating had not yet been recognized as a problem, the provisions of Sarbanes-Oxley requiring that insiders report the acquisition of securities, including options, within two days of receipt greatly hindered the ability of corporations to backdate options.
Two indictments have been issued and multiple guilty pleas have been entered in the most egregious cases. To a public corporation, the potential consequences of engaging in options backdating are manifold and can range from none whatsoever to having founders and CEOs going to prison. For example, in the case involving Brocade Communications, the SEC charged the former CEO and the former Vice President of Human Resources with criminally violating the securities laws.
In addition to the governmental investigations, more than 200 companies have completed, or are conducting, internal investigations — either because they want the comfort of knowing that they have not engaged in options backdating or they have an inkling that they did and want to be proactive in addressing the problem. In a follow-up study to his earlier work, Professor Lie estimated that 29 percent of 7,774 companies he surveyed backdated option grants to executives between 19. The facts of that case as set forth in the indictment were egregious.
In that case, corporate officers inserted backdated option grant dates into board of directors’ unanimous written consents that were transmitted to the compensation committee.
“Spring loading” involves the issuance of options immediately prior to the announcement of favorable financial news expected to have a positive impact on the underlying share price, thereby providing an immediate profit to the option holder.
the release of bad news that cause the stock price to take a temporary dip, which increases the probability that the option will become profitable in the short term.
As in other enforcement areas, the SEC has a penchant for pursuing through civil actions matters that involve blatant and intentional misconduct.
Of course, the imposition of an officer and director bar against those who are intimately involved with the backdating process can result in a corporation losing its founder or other key management personnel.